Capital Structure and Earnings Manipulation
University of Bridgeport - School of Business; University of Guelph - Department of Economics
June 14, 2010
Journal of Economics and Business, Forthcoming
We consider an optimal contract between an entrepreneur and an investor, where the entrepreneur is subject to a double moral hazard problem (one being the choice of production effort and the other being earnings manipulation). Since the entrepreneur cannot entirely capture the results of his effort, investment is below the optimal level and production effort is socially inefficient. The opportunity to manipulate earnings protects the entrepreneur against the risk of a low payoff when production is unsuccessful. Ex-ante, this provides an incentive for the entrepreneur to increase investment and improve effort.
Keywords: Earnings Manipulation, Intertemporal Substitution, Design of Securities, Property Rights, Double Moral Hazard
JEL Classification: G32, D92, D82Accepted Paper Series
Date posted: June 14, 2010
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